Tax Considerations for Inheriting an IRA

Inheriting an IRA comes with specific rules and potential tax consequences that vary depending on your relationship to the original account holder and the type of IRA you’ve inherited. Whether it’s a traditional IRA with tax-deferred contributions or a Roth IRA with tax-free distributions, each has distinct requirements for beneficiaries. The SECURE Act significantly changed the landscape by eliminating the “stretch IRA” option for many non-spouse beneficiaries, requiring most inherited accounts to be fully distributed within 10 years. This change can have substantial tax implications, potentially pushing beneficiaries into higher tax brackets during the distribution period. 

A financial advisor can help you think through your distribution options, understand how inherited IRA withdrawals may affect your taxes and coordinate those decisions with your broader estate plan.

IRA Inheritance From a Spouse

If you inherit a traditional IRA from your spouse, you have more flexibility than any other type of beneficiary. In most cases, you can either roll the assets into your own IRA or keep them in an inherited IRA, and each option comes with different tax and distribution rules.

If you choose to roll the IRA into your own account, it’s treated as if it were always yours. The funds continue growing on a tax-deferred basis, and any withdrawals you take are taxed as ordinary income. However, if you take distributions before age 59 ½, they may be subject to a 10% early withdrawal penalty. Required minimum distributions (RMDs) generally begin once you reach age 73 under current law.

Alternatively, you can keep the account as an inherited IRA. This approach may be useful if you need access to the funds before age 59 ½, since distributions from an inherited IRA are not subject to the 10% early withdrawal penalty. If the original account holder had not yet reached their required beginning date, you can generally delay distributions until the year they would have been required to start taking RMDs. If they had already begun taking RMDs, you may need to continue distributions based on applicable IRS rules.

The right choice depends on your age, income needs and long-term retirement strategy, as each option affects when distributions begin and how they are taxed.

IRA Inheritance From a Parent, Grandparent or Older Family Member

If you’re not the spouse of the original IRA holder, you can’t roll the new IRA into an existing IRA. The good news is that you’re not subject to the 10% penalty tax if you’re younger than 59 ½ when you start taking distributions.

For most non-spouse beneficiaries, the inherited IRA generally must be fully distributed by December 31 of the 10th year following the original owner’s death. In some cases, annual RMDs may also apply during years one through nine if the original owner had already reached their required beginning date.

The five-year rule generally applies to certain beneficiaries who are not designated beneficiaries, such as some estates, charities or certain trusts, rather than to most individual non-spouse beneficiaries.

Other than that, the recipient must still pay taxes as usual on any distributions coming out of the new IRA. IRA recipients who were gifted an IRA plan from a spouse or a parent share one common tax-related risk. By accepting the IRA assets, the recipient runs the risk of moving up to a higher tax bracket. That could mean digging into your pocket to pay more money to Uncle Sam come tax time, especially if you’re already having a high-income year.

A trusted tax attorney or a qualified financial advisor can walk you through options that might help manage the tax impact, such as spreading withdrawals over multiple years when allowed. Non-spouse beneficiaries generally cannot roll an inherited IRA into their own IRA.

Other IRA Inheritance Situations

If you’re a Roth IRA recipient, know that with a Roth plan, the assets are funded with post-tax income. This enables the account holder to accept distributions without having to pay any income tax. This means that if you inherit a Roth IRA, distributions are generally not subject to taxation if the account has satisfied the five-year holding requirement.

Otherwise, the same rules apply. If you’re receiving the Roth IRA from your spouse, distributions from an inherited IRA due to death are generally not subject to the 10% early withdrawal penalty. If you treat the Roth IRA as your own, standard Roth IRA rules apply, and Roth IRA owners are not subject to RMDs during their lifetime. If you’re a non-spousal recipient, most beneficiaries are generally subject to the 10-year rule, meaning the account must be fully distributed by the end of the 10th year.

Gifted IRA recipients have several options available if they accept an inherited IRA and elect to cash out immediately. Again, while you’ll pay income taxes, you won’t have to pay the 10% early withdrawal penalty. You may choose to withdraw the entire balance at once, but this is not required. Just know that cashing in all assets immediately with a gifted IRA could mean a big tax bill. State-issued taxes could apply, as well.

If that doesn’t work for you, slow things down and take out the IRA’s fund proceeds on a steady timeline. Your best move here is to establish an inherited IRA account, naming you, the recipient, as the beneficiary. Under this arrangement, most non-spouse beneficiaries are generally required to follow the 10-year rule, though certain eligible designated beneficiaries may take distributions based on life expectancy under IRS guidelines. Some accountants refer to this option as the “Stretch IRA,” though this approach is now limited to specific eligible beneficiaries under current law.

Inherited IRA Rules

Whether you are a spouse, non-spouse, or entity inheriting an IRA, the guidelines can significantly impact your tax obligations and withdrawal strategies. Here are some rules you need to understand if you’re leaving behind an IRA or inheriting one.

Types of Beneficiaries

The rules for inherited IRAs vary depending on whether you are a spouse, non-spouse, or entity beneficiary. Spouses can treat the IRA as their own, while non-spouse beneficiaries must follow specific distribution rules. Entities, such as trusts or estates, have guidelines that can affect how and when distributions are made.

Required Minimum Distributions (RMDs)

Non-spouse beneficiaries are generally required to fully distribute the account within 10 years, though annual RMDs may also apply during that period if the original account holder had already reached their required beginning date. Life expectancy distributions are generally limited to certain eligible designated beneficiaries. Spouses can delay RMDs until the deceased would have reached their required beginning date (generally age 73 under current law), offering more flexibility in planning.

Tax Implications

Withdrawals from an inherited IRA are typically subject to income tax, but the timing and amount can influence your tax bracket. Strategic planning can help minimize tax liabilities, especially in a higher tax bracket. Consulting with a tax advisor can provide personalized strategies to manage these implications effectively.

If you want to estimate how RMDs could affect your tax bill, try using an income tax calculator to model different withdrawal scenarios.

Distribution Options

Beneficiaries have several options for taking distributions, including lump-sum withdrawals, the 10-year rule, or life expectancy payments for eligible designated beneficiaries. Each option has its advantages and potential drawbacks, depending on your financial goals and needs. Evaluating these options can help you choose the best path for your situation.

Tips for Inheriting an IRA

Inheriting an IRA comes with specific rules and considerations that can significantly impact your financial future. Understanding these guidelines can help you maximize the benefits while avoiding costly mistakes.

Tips for Inheriting an IRA

Inheriting an IRA comes with specific rules and considerations that can significantly impact your financial future. Understanding these guidelines can help you maximize the benefits while avoiding costly mistakes.

Understand Your Beneficiary Status

Your relationship to the original account holder determines your options. Spouses have the most flexibility, including the ability to roll the inherited IRA into their account or remain a beneficiary. Non-spouse beneficiaries face more restrictions and typically must follow the 10-year distribution rule established by the SECURE Act.

Learn the Distribution Rules

The SECURE Act eliminated the “stretch IRA” option for most non-spouse beneficiaries. Now, most inherited IRAs must be fully distributed within 10 years of the original owner’s death. However, certain eligible designated beneficiaries, including minor children and disabled individuals, may still qualify for extended distribution periods.

Consider Tax Implications

Distributions from traditional inherited IRAs are generally taxed as ordinary income. Taking large distributions could push you into a higher tax bracket, potentially increasing your tax burden. Strategic planning of withdrawals over the allowed timeframe can help minimize the tax impact.

Meet Required Minimum Distributions (RMDs)

If the original account holder had already reached their required beginning date, annual distributions may still be required during the 10-year period, depending on your beneficiary status. Failing to take required distributions can result in a substantial 25% penalty on the amount that should have been withdrawn. The penalty drops to 10% if the RMD is corrected within two years.

Consult With Professionals

The rules for inheriting an IRA are complex and can change with new legislation. Working with financial advisors and tax professionals who specialize in retirement accounts can help you navigate these complexities and develop a strategy that aligns with your financial goals.

Bottom Line

Inheriting an IRA can provide valuable financial support, but the tax treatment and distribution requirements depend on your relationship to the original owner, the type of account and the rules that apply to your situation. Knowing when distributions are required and how they are taxed can help you make more informed decisions about how and when to withdraw funds.

Tips for Managing Your Retirement Plans

• Managing your retirement assets can be a lot to handle on your own but a financial advisor can help you with the entire process. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Curious how far your current assets will get you in retirement? Our retirement calculator can help shed some light on the matter. Just tell us where you plan to retire, your current annual income, your monthly savings, your anticipated annual retirement expenses and your Social Security election age. Using this information, you can see how much more you need to save to reach your goals.

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